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(a) The weak form of the efficient market hypothesis states that the current share price reflects all
information contained in the past price movements of that share. This implies that a study of the
trends in share prices over a prior period will not help in predicting the way in which the value or
price of those shares will move in the future. In other words there is no place for Chartism or
technical analysis. Statistical evidence suggests that the efficient market hypothesis does hold in its
weak form.
The semi-strong form of the efficient market hypothesis encompasses the weak form and adds that
share prices also reflect all current publicly available information, for instance a detailed analysis of
published accounts. If the semi-strong form holds, then a detailed analysis of published accounts will
not assist in a prediction of future share price movements, since the share price already contains all
relevant information shown in those accounts or made public since the issue of those accounts. As
such it would only be possible to predict share price movements if unpublished information were
known, in other words through insider information. Statistical evidence suggests that the semi-strong
form of the efficient market hypothesis is valid.
The strong form of the efficient market hypothesis proposes that the current share price reflects all
information relevant to the company, whether or not that information has been made public. If this
is the case then it will never be possible to predict share price movements. The implication of this
statement is that there would be no scope for gains to be made on share trading through the
obtaining of inside (unpublished) information. Clearly this appears not to hold in practice, since
legislation has been set to prevent insider dealing.
(b) Share price rises after announcement of high earnings.
The market will have assessed the likely level of the company's earnings from information which
has been available to the public and the share price will be based on that assessment. If subsequent
information suggests that the estimate of earnings was inaccurate the share price should adjust immediately under the semi-strong form of the efficient market hypothesis. In the situation
described there was an immediate share price movement, but this continued over the following two
or three days. This would suggest that the market is not absolutely efficient in the semi-strong form,
because if it were the entire adjustment should have occurred immediately on announcement of the
earnings figure.
It is also true that the market is not efficient in the strong form, otherwise the high earnings figure
would have been known before it was published and as such reflected in the share price. Since the
share price moved on announcement of the earnings, the strong form cannot hold.
Return on professionally managed portfolios
The suggestion that the return on professionally managed portfolios is likely to be no better than that which
could be achieved by any investor would be supported by the strong form of the efficient market hypothesis.
Assuming portfolio managers are not party to inside, unpublished information, this view would also be held
by the semi-strong form of the efficient market hypothesis. However, if this proposition were to be unduly
accepted there would be no demand for professionally managed portfolios. Since this is not the case,
investors must perceive some benefit of placing their funds in the hands of portfolio managers. This would
therefore suggest that the market is not efficient in either the semi-strong or strong form.
Share price movements around the fiscal year end.
The downward movement on share prices just before the year end followed a subsequent upward movement
is due more to supply and demand effects than the efficient market hypothesis. There is no information
specific to a particular security which causes the managers of portfolios or other investors to sell and then re-buy:
it is simply the result of tax effects which apply universally to all shares across the market.
Kavungya answered the question on April 22, 2021 at 06:57
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Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but as a result of the closure of many coal mines and
depleted coal resources, is now considering what type of new power station to invest in. The alternatives
are a gas fueled power station, or a new type of efficient nuclear power station.
Both types of power station are expected to generate annual revenues at current prices of Sh.800 million.
The expected operating life of both types of power station is 25 years.
Other information:
(i) Whichever power station is selected, electricity generation is scheduled to commence in three
years time.
(ii) If gas is used most of the workers at the existing coal fired station can be transferred to the new
power station. After tax redundancy costs are expected to total Sh.4 million in year four. If nuclear
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per year in the UK and an average of 5% per year in the member countries of the Euro bloc in
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Market data:
Uniglow's current share price: Sh.20
Call option exercise price: Sh.20
Time to expiry: 3 months
Interest rates (annual): 6%
Volatility of Uniglow's shares 50% (standard deviation per year)
Assume that option contracts are for the purchase or sale of units of 1,000 shares.
Required:
(i) Devise a delta hedge that is expected to protect the investment against changes in the share price
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Issue costs are estimated to be 1% for debt financing (excluding the subsidized loan), and 4% for
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The corporate tax rate is 30%.
Required:
(a) Estimate the Adjusted Present Value (APV) of the proposed investment.
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Date posted: April 20, 2021. Answers (1)
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Required:
(a) Evaluate which project should be selected. Do not use information provided later in the question
requirements in your evaluation.
State clearly any assumptions that you make in all parts of this question.
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Required:
(a) Explain, with supporting evidence, the current dividend policy of TYR plc, and briefly discuss
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(b) Identify and consider additional information that might assist the managers of TYR in assessing
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Date posted: April 20, 2021. Answers (1)